To new investors, the stock market presents a bewildering range of options. There are dozens of systems and methods of investing, all with their pros and cons. But underneath it all, investing breaks falls into five basic methods:
Although there’re thousands of theories, investing in stocks & bonds boils down to five general methods.
If you tallied every book ever written on investing, you’d account for the deaths of at least two rainforests. While the variety is confusing, it exists for a good reason: almost no one agrees on a single, best way to invest.
The best investment method depends on two main factors: your investment horizon, and yourfinancial goals.
Some people want to make a million dollars in 10 years. Some want a passive income of $3,000 a month, by the time they hit 50. The methods they use will have to be tweaked to suit their ambitions.
Method #1: The Tortoise Method
This method is the “slow and steady” approach to wealth. It will never make you a million dollars in a year (Or five years. Or 10 years).
But this method seldom loses money, and is as low risk as you can get.
The tortoise method features investments in “safe” assets, and its favourites are blue chip stocks, and investment grade bonds.
The one animal that’s so boring, it’s perfectly safe from bulls and bears.
Blue Chip Stocks
Blue chip stocks are stocks in large, well-established companies. These companies have long histories, and are the most financially stable in the market.
Only 30 of the 800+ companies listed on SGX are blue chip. As of 2012, all 30 of those companies posted profits.
Investment Grade Bonds
Bonds come with a bond credit rating, which measures credit worthiness. An investment grade bond (AAA, AA+, or AA) means the bond issuer is unlikely to default.
Investment grade bonds pay out less in coupons (the interest on the bond, which is usually paid out annually or every six months), compared to high yield (or junk) bonds. However, “tortoise” investors prefer them, as junk bonds have higher rates of default (which may cost bond holders money).
Who Can Use This Method?
The investor’s best assets are not in the portfolio. These are time and compounding interest.
The tortoise method is ideal for retirement planning. It is attractive to young investors, who can tolerate long investment horizons of 20 to 30 years. It can also be used for a child’s university fund, or to make the down payment on a house in 10 or 15 years.
Method #2: Growth Investing
Growth investors pursue wealth through capital appreciation. Here’s an example of that:
Say you buy a stock for $3.22 per share. In a month, the price rises to $3.47 per share. If you sell at that point, your capital appreciation is the difference of 0.25 cents per share.
Growth investors are not too interested in dividend pay outs, or bond coupons. Their main preoccupation is selling a stock for more than they bought it.
Note that growth investing is a form of active trading. Growth investors must keep monitoring the market, and be ready to buy or sell at short notice.
Also, while growth investment can lead to faster wealth, few people are “pure” growth investors. Many will seek to balance their portfolio, by having at least some assets dedicated to passive returns / capital protection.
A common asset choice among growth investors is…
Small-Cap Stocks
Growth investors need to know the direction of the industry, not just how to read stock charts.
A “small-cap” company refers to companies that are in early stages of growth. These companies are believed to have significant growth potential (e.g. maybe it’s the next Google or Apple).
Small cap stocks can be volatile (the share values fluctuate often). But growth investors seek to buy small-cap stocks when they are still cheap, and sell them at sky high prices when the company takes off.
Who Can Use This Method?
Growth investing is inadvisable for beginners. It takes skilled analysis to make accurate growth predictions.
In many cases, investors who use this method are experts in certain industries (e.g. healthcare or IT), who know the “growth areas” in their different fields.
Nonetheless, investors who want faster returns might dedicate some of their portfolio to growth investing. This should not be done without initial education, so do check out the educational tools onSGX MyGateway or attend courses organised by SGX academy first.
Method #3: Value Investing
Value investors believe that sometimes…. just sometimes… the market gets its prices wrong.
Value investors trawl for stocks that are presently undervalued. In other words, stocks that are too cheap for the dividend pay outs or growth potential they provide. Value investors want to buy these stocks before market forces “correct” the pricing error.
Simplified example: it’s like noticing something’s too cheap at the supermarket, and quickly buying all of it before the cashier puts on the right price tag.
Value investors believe market pricing is imperfect. Sometimes, you can find a stock that’s too cheap.
Value investors spot these stocks through close analyses of companies rather than share prices. Rather than look at trading histories, they consider the motivation of a company’s employees, size of its market segments, its innovation, etc.
In short, they invest in the company, and not the stock.
Some rough techniques that value investors look at:
- The company should preferably be owned by the employees (e.g. they have stock options)
- The company’s current assets should be twice the current liabilities
- Growth in earnings should be at least 7% per annum, over the past 10 years
- The P/E Ratio should be low (around 15)
Value investors also set a margin of safety, to compensate for errors when estimating the intrinsic value of a stock. The further a stock’s price is below its intrinsic value, the greater the margin of safety afforded.
Who Can Use This Method?
Value investing rewards the detail oriented. These investors must know how to read prospectuses and annual reports in-depth. They should also have the basic skills necessary to evaluate a business.
Many stock brokers will advise clients along the principles of value investing. If you listen to your broker, this is probably what you’ll end up doing (whether you realise it or not!)
Method #4: Speculative Investing
If your investment methods have casino levels of excitement…you’re doing it wrong.
This is a “method” in the same way pulling a Jackpot lever is a “method”. It exists, but there’s little to recommend it.
Also known as “punting”, this is a high-risk, high reward approach. It mainly involves buying penny stocks (super cheap stocks in start-ups or at-risk companies) and junk bonds. The investor then hopes these assets will appreciate.
Statistically, speculators lose in the long run. However, some are tempted by the prospect of quick cash.
2%, so you’d want to rake in about 5% to 7% returns in Singapore.
Choose a balance between speed and safety, when it comes to your money. And while you should always consult a professional advisor, be sure to educate yourself!
Remember: you can’t evaluate your progress if you don’t know what’s going on.
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